How FX Options Trading Works

Posted by Sonal Mistry on 8/4/21 9:10 AM

FX Options

 

What are FX Options?

An FX Option is a financial instrument giving the owner of the option the right, but not the obligation, to purchase or sell currency at a predetermined rate within a given time frame. Vanilla FX Options are simply options that have no special features but can be tailored to the exact needs of the buyer.

Is The Premium Worth The Cost?

The premium is a function of several factors including the strike price, duration of the option, foreign and domestic interest rates, and volatility of the underlying currency.

Paying a small premium gives the buyer the option to either purchase or sell at the strike price. The buyer is under no obligation to move forward with the transaction and is therefore able to take advantage of all favourable exchange rate movements. 

 

Types Of Vanilla FX Options

Call Options

A Call Option gives the right to BUY currency at the strike price within a specific time period.

Put Options

A Put Option gives the right to SELL currency at the strike price within a specific time period.

 

Key Elements Of An Option

Key elements of an optionHow Options Work

Call Option Example

Canadian Company ABC imports product from the USA and needs to pay its vendor $500,000 USD in 3 months. A 3-month FX Outright Forward can be executed today at 1.3670, but the company wants to pay no more than 1.3600.

Company ABC purchases a 3-month $500,000 USDCAD FX Call Option at 1.3600

Vanilla Call Options Payoff Diagram

 

Put Option Example

Canadian Company XYZ is bidding on a project with the German government. They can expect to receive 5 million EUR in 6 months should they be awarded the project. EURCAD is currently at 1.5300 which is attractive to the company. They want to secure the rate without an obligation to convert the Euros to Canadian dollars should they lose the bid.

Company ABC purchases a 3-month $500,000 USDCAD FX Call Option at 1.

Vanilla Put Options Payoff Diagram

 

Advantages Of Using FX Options

To summarize, these are the benefits of using Vanilla Options as part of your FX strategy:

  • Guaranteed cost/rate to protect profits
  • Highly customizable and can be structured to hedge a specific rate and duration
  • Limited, defined risk which is the premium paid
  • Not necessary to wait until the date of maturity to close

Speak with one of our Account Managers if you think you may benefit from booking a FX Option. Schedule a 15 minute, no-obligation consultation today to get started.

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